Definition
Accounts Receivable is an asset account in the general ledger that documents amounts customers owe to a business for goods or services provided on credit. In double-entry bookkeeping, it is increased, or debited, when a sale is made on credit. Conversely, it is decreased, or credited, when payment is received from the customer.
Key Takeaways
- Accounts Receivable represents the money owed to a company by its customers. It is an asset account, hence increases are recorded as debits and decreases are recorded as credits.
- Whenever a sale is made on credit, the company debits Accounts Receivable to increase the balance and when payment is received, it credits the Accounts Receivable to decrease the balance.
- The balance in Accounts Receivable is necessary for preparing financial statements. An accurate record of receivables allows businesses to assess revenue performance and financial health in a timely manner.
Importance
Accounts Receivable (AR) – Debit or Credit, is largely important in the world of finance because it governs the recording and tracking of money owed to a business by its clients.
As an asset account, increases, reflecting money owed to the business, are typically recorded as debits, while decreases are filed as credits.
The proper management and understanding of Accounts Receivable, and whether to categorize transactions as debit or credit, directly impacts a company’s balance sheet, profit margin, and the overall cash flow.
Therefore, it’s not only central to accounting processes, but it’s instrumental in assessing a business’s financial health, profitability, and operational efficiency.
Explanation
Accounts Receivable is a finance term that signifies the amount of money owed to a company by its customers who have purchased its goods or services on credit. Essentially, it is noted as an asset on the company’s balance sheet because it represents a legal obligation for the customer to pay an outstanding amount.
These are recorded as a debit because, from the company’s perspective, this represents future revenues that the company is entitled to receive. The primary purpose of Accounts Receivable is to keep track of a company’s upcoming revenues owed by customers.
Its role is crucial in managing a company’s cash flow adequately. Too much Accounts Receivable could mean that cash inflow is tied up with customers who are slow at paying their dues, while too little could imply that the company is not making enough sales on credit.
It assists in credit management and is pivotal in determining the company’s profitability and financial health.
Examples of Accounts Receivable – Debit or Credit
**Small Business Sale** – A local boutique sells clothing to one of its regular customers having his own fashion retail shop. The customer doesn’t pay immediately and promises to pay in 30 days. The boutique would then record this transaction as a debit to Accounts Receivable. Being a debit, this means the boutique expects an increase in its assets when the customer pays.
**Consultancy Services** – A management consultancy firm offering services to a large corporation, would send an invoice after the completion of the services. The invoice total is recorded as a debit in the consultancy firm’s accounts receivable. This implies that the company is waiting to receive the payment.
**Telecommunications Company** – A phone company offers postpaid services to its customers who pay at the end of the month. At the beginning of the month, all the bills sent out are recorded as debits in the company’s Accounts Receivable. Once customers pay their bills, the amount in Accounts Receivable decreases with corresponding credit entries.
FAQs: Accounts Receivable – Debit or Credit
1. What is Accounts Receivable?
Accounts receivable refers to the outstanding invoices a company has, or the money that the company is owed from its clients. In other words, if a company sells something to a customer and the customer doesn’t pay immediately, then the money the customer owes the company is known as the company’s accounts receivable.
2. Is Accounts Receivable a Debit or Credit?
Accounts Receivable is an asset account and is increased with a debit and decreased with a credit. When you sell to a customer on credit, you debit Accounts Receivable and credit Sales Revenue. When the customer pays off their accounts, you debit Cash and credit the Accounts Receivable.
3. How does Accounts Receivable impact the balance sheet?
Accounts receivable is listed as a current asset on the seller’s balance sheet. The amount represents the total invoices outstanding at the end of the period and due to from customers. If accounts receiveable are growing, this may be a sign that customers are being given longer to pay their bills, which may be a warning sign of financial trouble ahead.
4. What is the difference between Accounts Receivable and Accounts Payable?
Accounts Receivable (AR) is the amount of money owed by customers to a company in the short term, whereas Accounts Payable (AP) is the amount a company owes to suppliers or vendors. Accounts Receivable is an asset, while Accounts Payable is a liability.
5. How do I reduce Accounts Receivable?
Reducing accounts receivable can be achieved by tightening credit requirements, offering discounts to customers who pay their bills early, request a deposit for large purchases, pursuing receivable collections more aggressively, or factoring (selling accounts receivable at a discount to a third party).
Related Entrepreneurship Terms
- Invoice: It is an itemized billing statement that outlines the goods and services provided, quantities, prices, and total charges. In accounts receivable, it forms the basis for recording a debit or credit transaction.
- Collection Period: This term refers to the average number of days it takes for a business to collect payments from its credit sales. A shorter collection period is desirable in accounts receivable management.
- Bad Debt: This term refers to revenues that a company is unable to collect. In accounting, bad debts can be marked as debits in accounts receivable.
- Allowance for Doubtful Accounts: This is a contra asset account used to lower the total accounts receivable reported when some of them are expected not to be paid back.
- Accounts Receivable Aging Report: This is a tracking system used by businesses to see which invoices are overdue for payment. It helps companies manage their receivables and collect them efficiently.
Sources for More Information
Sure, here are four reliable sources to learn more about the finance term: “Accounts Receivable – Debit or Credit”:
